Why is a 401(k) such a good deal?
- What are defined contribution plans?
- How do defined contribution plans work?
- How does the money get invested?
- What tax benefits do 401(k)s offer?
- Do I have to contribute to my plan?
- Why is a 401(k) such a good deal?
- When do I pay tax on a 401(k)?
- How is a Roth 401(k) different?
- What is a matching contribution?
- How does vesting work exactly?
- How much should I contribute to my plan?
- What if I can't invest the maximum right now?
- What if I need the money before I retire?
- What if I leave my job?
Two main reasons: You get tax breaks, plus - in some cases - a bonus from the boss, known as a matching contribution.
First of all, money you deduct from your paycheck and invest in a defined contribution plan is pretax money. That means it's taken out of your paycheck before your income taxes are calculated. (This is not the case with Roth plans, which work differently. For more, see How is a Roth 401(k) different?) That means that your contributions effectively lower the amount of income you get taxed on.
Second, as long as your money stays in the plan, you won't pay a penny in tax on your investment returns. All the money you invest compounds year after year without any tax bill from Uncle Sam - at least until you're ready to retire.
